Fed Watch: Paulson See 'Bending' Jobs Market; Yellen Warns of Debt Spirals

WikiFX

| 2026-01-05 16:00

Abstract：Philadelphia Fed President Anna Paulson suggests a 'bending not breaking' labor market could allow for rate cuts later in 2026, while Janet Yellen warns that political pressure on the central bank risks a crisis of 'Fiscal Dominance.'

As the Federal Reserve navigates the opening of 2026, policymakers are caught between a cooling labor market and escalating fiscal tensions. Philadelphia Fed President Anna Paulson offered a cautiously dovish outlook this weekend, while former Fed Chair Janet Yellen sounded the alarm on the independence of monetary policy.

Paulson: “Bending, Not Breaking”

Speaking ahead of the Allied Social Science Associations Annual Meeting, Anna Paulson characterized the US labor market as “bending not breaking.”

Policy Path: Paulson indicated that if inflation continues its downward trajectory and the economy grows at a moderate 2% pace, a “modest” rate cut late in 2026 would be appropriate.

Data Dependence: She noted that recent high unemployment prints (4.6% in November) are concerning but contrasted them with strong Q3 GDP growth (4.3%).

Inflation Outlook: While acknowledging that new tariffs could temporarily boost goods inflation in H1 2026, she expects these effects to dissipate by year-end.

The Threat of “Fiscal Dominance”

Countering the standard monetary narrative, former Treasury Secretary Janet Yellen issued a stark warning regarding the US debt trajectory. With the federal deficit projected to hit $1.9 trillion and debt-to-GDP ratios pushing towards 118% within a decade, Yellen warned of “Fiscal Dominance.”

This economic condition occurs when a central bank is forced to keep interest rates low not to manage inflation, but to prevent the government from defaulting on its debt servicing costs. Yellen highlighted President Trump's public demands for lower rates as a “precondition” for this dangerous scenario.

Market Implications

Treasury Yields: The 10-year yield rose 2.5 basis points to 4.192% last week. The conflict between a Fed wanting to hold rates steady to fight tariff-induced inflation and a White House demanding cuts to fund debt could lead to increased volatility in the bond market.

USD Impact: While the Dollar Index (DXY) remains strong on safe-haven flows, long-term institutional confidence is being tested by concerns over institutional independence and fiscal health.